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Principles of Microeconomics, Third Edition
John B. Taylor, Stanford University
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Economic Regulation Versus Social Regulation

Economic regulation
is defined as a type of government regulation that sets prices or conditions on entry of firms into an industry. Economic regulation also includes the regulation of financial firms. However, economic regulation is not the only type of government regulation, as the discussion of the environmental regulations in Chapter 15 indicates. This other type of regulation, called social regulation includes environmental controls, health and safety regulations, and restrictions on labeling and advertising. Social regulation involves the correction of externalities. However, there is considerable disagreement about the exact economic rationale for much social regulation.

The table below provides a list of the key federal government agencies involved in social and economic regulation. We discuss the Environmental Protection Agency (EPA) in Chapter 15. Its role is to control pollution. The Food and Drug Administration (FDA) approves new drugs, regulates advertising for food and drugs, and provides standards for labeling on food packages. The Occupational Safety and Health Administration (OSHA) requires that employers inform workers about risks and mandates firms to reduce risks. The National Highway and Traffic Safety Administration (NHTSA) monitors risks and sets standards for automobiles and highways. The Federal Aviation Administration (FAA) sets standards for airline safety. The Consumer Product Safety Administration examines goods for risk. The Federal Trade Commission (FTC), discussed earlier, also regulates information in advertising. In the 1970s, for example, it challenged the ads for various aspirins, including Bayer, Anacin, and Bufferin.

Key Federal Regulatory Agencies

Social Regulation
Economic Regulation
  • Consumer Product Safety Commission (CPSC)
  • Federal Communications Commission (FCC)
  • Food and Drug Administration (FDA)
  • Federal Energy Regulatory Commission (FERC)
  • Federal Aviation Administration (FAA)
  • Financial
  • National Highway and Traffic Safety Administration (NHTSA)
  • Comptroller of the Currency (OCC)
  • Occupational Safety and Health Administration (OSHA)
  • Federal Reserve System (Fed)
  • Environmental Protection Agency (EPA)
  • Securities and Exchange Commission (SEC)

Two Trends

One reason to distinguish economic regulation from social regulation is that the two have followed very different paths in recent years. There has been a rapid expansion of social regulation and a decline in economic regulation, as described earlier. Just as the economic deregulation movement was beginning in the 1970s, more social regulatory agencies—including the EPA and OSHA—were created. There appears to have been a great public demand for the federal government to take a more active role in social regulation. But the fact that such regulations appear to be popular does not mean that they are without fault.

Benefits and Costs Again

An analysis of the benefits of much social regulation can be cast in terms of information and risk. Recall that there are externalities associated with information and risk. If every person who flew on an airplane had to have it checked for safety, the costs would be huge. It is much cheaper to have an agency like the FAA check for airline safety. When the FAA sees a way to make a change in safety requirements that will reduce risk and thereby save lives, it has the authority to require that the airlines make these changes. Similarly, it would be costly for each consumer to check the accuracy of all advertising claims, or to test the efficacy of a new drug. By giving the FDA responsibility for testing new drugs, the public saves considerably on time and effort.

To be sure, without the government, private organizations would probably evolve to provide testing and information about products. Consumers Union is one such organization, and many industries have private watchdog organizations. But because of information externalities, the private actions would probably fall short of the efficient level.

The benefits from providing information about risks must be considered in light of the costs. The FDA might hold back a new drug for testing to reduce risks, but this is costly to the people whose lives could be saved if the drug were approved. The building code requirements for a construction site might raise the cost of construction significantly. Frequently, these costs are not visible. No one knows that an illness might have been prevented with a new drug, but everyone knows when a faulty new drug causes severe illness or death.

The actions of the FDA, OSHA, and other agencies involved in social regulation are frequently criticized because of the costs they impose on firms and consumers. Irate letters and critical editorials about the costs are common. It is very difficult to estimate the costs, but some economists have tried. The estimates range from around 3 to 5 percent of GDP per year for all programs. On the other side, the programs are popular, and they clearly do reduce risks and provide information.

Ultimately, the degree of government intervention will be decided in the give and take of the political process. But careful cost-benefit analysis on a program-by-program basis, as urged by many economists, would help in the decision-making process. For example, economists estimate that the cost of the FAA regulations on airplane cabin fire protection is $200,000 per life saved, which would appear to pass any reasonable cost-benefit analysis. On the other hand, the EPA land disposal regulations and the OSHA formaldehyde regulation cost $3.5 billion and $72 billion per life saved respectively. Most would say that scarce resources could be used to save lives in better ways. Estimates based on people’s willingness to accept more risky jobs in comparison to less risky jobs indicate a value of between $1 million and $7 million per life.